The Hershey Company - 10-Q quarterly report FY

Common Stock, $1 par value – 166,215,273 shares, as of July 18, 2008.  Class B Common Stock,

$1 par value – 60,805,727 shares, as of July 18, 2008.

The accompanying notes are an integral part of these consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

Our unaudited consolidated financial statements provided in this report include the accounts of the Company and our majority-owned subsidiaries and entities in which we have a controlling financial interest after the elimination of intercompany accounts and transactions.  We have a controlling financial interest if we own a majority of the outstanding voting common stock and minority shareholders do not have substantive participating rights, or we have significant control over an entity through contractual or economic interests in which we are the primary beneficiary. We prepared these statements in accordance with the instructions to Form 10-Q.  These statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

In May 2007, we entered into an agreement with Godrej Beverages and Foods, Ltd., one of India’s largest consumer goods, confectionery and food companies, to manufacture and distribute confectionery products, snacks and beverages across India.  Under the agreement, we invested $61.5 million during 2007 and own a 51% controlling interest in Godrej Hershey Ltd. (formerly Godrej Hershey Foods and Beverages Company). Total liabilities assumed in 2007 were $51.6 million. Effective in May 2007, this business acquisition was included in our consolidated results, including the related minority interest.

Also in May 2007, we entered into a manufacturing agreement in China with Lotte Confectionery Co., LTD., to produce Hershey products and certain Lotte products for the market in China. We invested $39.0 million in 2007 and own a 44% interest. We are accounting for this investment using the equity method.

In January 2008, our Brazilian subsidiary, Hershey do Brasil, entered into a cooperative agreement with Pandurata Alimentos LTDA (“Bauducco”), a leading manufacturer of baked goods in Brazil whose primary brand is Bauducco. The arrangement with Bauducco will leverage Bauducco’s strong sales and distribution capabilities for our products throughout Brazil. Under this agreement we will manufacture and market, and they will sell and distribute our products. In the fourth quarter of 2007, we recorded a goodwill impairment charge and approved a business realignment program associated with initiatives to improve distribution and enhance performance of our business in Brazil. In the first quarter of 2008, we received approximately $2.0 million in cash and recorded an other intangible asset of $13.7 million associated with the cooperative agreement with Bauducco in exchange for a 49% interest in Hershey do Brasil. We will maintain a 51% controlling interest in Hershey do Brasil.

The Hershey Company Equity and Incentive Compensation Plan (“EICP”) is the plan under which grants using shares for compensation and incentive purposes are made.  The following table summarizes our stock compensation costs:

The increase in share-based compensation expense for the second quarter of 2008 resulted from the impact of lowered performance expectations for the PSUs in 2007.

The increase in share-based compensation expense for the first six months of 2008 resulted from the impact of lowered performance expectations for the PSUs in 2007 and the timing of the 2007 stock option grants.  Our annual grant of stock options to management level employees, which customarily has occurred in February of each year, was delayed in 2007 pending approval by our stockholders of the EICP at the annual meeting in April 2007. In 2008, we resumed our customary February grant schedule.

We estimated the fair value of each stock option grant on the date of the grant using a Black-Scholes option-pricing model and the weighted-average assumptions set forth in the following table:

A summary of the status of our performance stock units and restricted stock units as of June 29, 2008, and the change during 2008 is presented below:

As of June 29, 2008, there was $14.8 million of unrecognized compensation cost relating to non-vested performance stock units and restricted stock units.  We expect to recognize that cost over a weighted-average period of 2.9 years.

The higher 2007 amount was due to the payment of awards earned for the 2004-2006 performance stock unit cycle. In 2008, no payment was made for the 2005-2007 performance stock unit cycle based on the Company’s performance against the two financial objectives which fell below the threshold levels required to earn an award.

Deferred performance stock units, deferred restricted stock units, and directors’ fees and accumulated dividend amounts representing deferred stock units totaled 430,811 units as of June 29, 2008.  Each unit is equivalent to one share of the Company’s Common Stock.

No stock appreciation rights were outstanding as of June 29, 2008.

For more information on our stock compensation plans, refer to the consolidated financial statements and notes included in our 2007 Annual Report on Form 10-K and our proxy statement for the 2008 annual meeting of stockholders.

In February 2007, we announced a comprehensive, three-year supply chain transformation program (the “global supply chain transformation program”) and, in December 2007, we initiated a business realignment program associated with our business in Brazil (together, “the 2007 business realignment initiatives”).

When completed, the global supply chain transformation program will greatly enhance our manufacturing, sourcing and customer service capabilities, reduce inventories resulting in improvements in working capital and generate significant resources to invest in our growth initiatives.  This program will provide for accelerated marketplace momentum within our core U.S. business, creation of innovative new product platforms to meet customer needs and disciplined global expansion.

The estimated pre-tax cost of the program announced in February 2007 was from $525 million to $575 million over three years.  The total included from $475 million to $525 million in business realignment costs and approximately $50 million in project implementation costs.  The costs will be incurred primarily in 2007 and 2008.  Total costs of $400.0 million were recorded in 2007 and total costs of $66.0 million were recorded during the first six months of 2008 for this program.

In 2001, we acquired a small business in Brazil, Hershey do Brasil, which has not gained profitable scale or adequate market distribution. In an effort to improve the performance of this business, in January 2008 Hershey do Brasil entered into a cooperative agreement with Bauducco. In the fourth quarter of 2007 we recorded a goodwill impairment charge of $12.3 million associated with Hershey do Brasil, along with a business realignment charge of $.3 million primarily related to employee separation costs. Business realignment charges of $3.9 million were recorded in the first six months of 2008.

Charges (credits) associated with business realignment initiatives recorded during the three-month and six-month periods ended June 29, 2008 and July 1, 2007 were as follows:

The charge of $40.2 million recorded in cost of sales during the first six months of 2008 related primarily to the accelerated depreciation of fixed assets over a reduced estimated remaining useful life and start-up costs associated with the global supply chain transformation program.  The $3.9 million recorded in selling, marketing and administrative expenses related primarily to project administration for the global supply chain transformation program.  In determining the costs related to fixed asset impairments, fair value was estimated based on the expected sales proceeds.  The $6.8 million of gains on sale of fixed assets resulted from the receipt of proceeds in excess of the carrying value primarily from the sale of a warehousing and distribution facility. The $15.3 million of fixed asset impairments and plant closure expenses for 2008 related primarily to the preparation of plants for sale and line removal costs.  The global supply chain transformation program employee separation costs included $7.0 million related to involuntary terminations at the North American manufacturing facilities which are being closed and $4.9 million primarily related to pension settlements.

The charges (credits) for the Brazilian business realignment were related to costs for involuntary terminations and costs associated with office consolidation related to the cooperative agreement with Bauducco.

The charge of $41.3 million recorded in cost of sales during the second quarter of 2007 related to the accelerated depreciation of fixed assets over a reduced estimated remaining useful life and costs related to inventory reductions.  The $3.3 million recorded in selling, marketing and administrative expenses related primarily to project administration.  In determining the costs related to fixed asset impairments, fair value was estimated based on the expected sales proceeds.  The employee separation costs included $22.3 million for involuntary terminations at the North American manufacturing facilities which have been closed or are being closed.  The employee separation costs also included $29.2 million for charges relating to pension and other post-retirement benefits curtailments and special termination benefits.

The charge of $51.2 million recorded in cost of sales during the first six months of 2007 related to the accelerated depreciation of fixed assets over a reduced estimated remaining useful life and costs related to inventory reductions.  The $6.3 million recorded in selling, marketing and administrative expenses related primarily to project administration.  In determining the costs related to fixed asset impairments, fair value was estimated based on the expected sales proceeds.  The employee separation costs included $23.7 million for involuntary terminations and $29.2 million for charges relating to pension and other post-retirement benefits curtailments and special termination benefits.

The June 29, 2008 liability balance relating to the 2007 business realignment initiatives was $46.6 million for employee separation costs.  During the first six months of 2008, we made payments against the liabilities recorded for the 2007 business realignment initiatives of $30.3 million principally related to employee separation costs.

In accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share, we compute Basic and Diluted Earnings Per Share based on the weighted-average number of shares of the Common Stock and the Class B Common Stock outstanding as follows:

The Class B Common Stock is convertible into Common Stock on a share for share basis at any time. In accordance with proposed Financial Accounting Standards Board (“FASB”) Staff Position No. FAS 128-a, Computational Guidance for Computing Diluted EPS under the Two-Class Method, the calculation of earnings per share-diluted for the Class B Common Stock was performed using the two-class method and the calculation of earnings per share-diluted for the Common Stock was performed using the if-converted method.

For the three-month and six-month periods ended June 29, 2008, 12.8 million stock options were not included in the diluted earnings per share calculation because the effect would have been antidilutive. For the three-month and six-month periods ended July 1, 2007, 5.6 million stock options were not included in the diluted earnings per share calculation because the effect would have been antidilutive.

We account for derivative instruments in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133”).  SFAS No. 133 requires us to recognize all derivative instruments at fair value. We classify the derivatives as assets or liabilities on the balance sheet. As of June 29, 2008 and July 1, 2007, all of our derivative instruments were designated as cash flow hedges.

Our cash flow hedging derivative activity during the three months and six months ended June 29, 2008 and July 1, 2007 was as follows:

The amount of net gains on cash flow hedging derivatives, including foreign exchange forward contracts, interest rate swap agreements and commodities futures contracts, expected to be reclassified into earnings in the next twelve months was approximately $26.8 million after tax as of June 29, 2008. This amount was primarily associated with commodities futures contracts.

For more information, refer to the consolidated financial statements and notes included in our 2007 Annual Report on Form 10-K.

A summary of the components of comprehensive income (loss) is as follows:

The components of accumulated other comprehensive income (loss) as shown on the Consolidated Balance Sheets are as follows:

We value the majority of our inventories under the last-in, first-out (“LIFO”) method and the remaining inventories at the lower of first-in, first-out (“FIFO”) cost or market. Inventories were as follows:

The increase in raw material inventories as of June 29, 2008 resulted from the timing of deliveries to support manufacturing requirements and higher prices in 2008. The increase in finished goods inventories was primarily associated with seasonal sales patterns and the introduction of new products.

As a source of short-term financing, we utilize commercial paper or bank loans with an original maturity of three months or less. In December 2006, we entered into a five-year unsecured revolving credit agreement. The credit limit is $1.1 billion with an option to borrow an additional $400 million with the concurrence of the lenders. During the fourth quarter of 2007, the lenders approved a one-year extension to the term of this agreement in accordance with our option under the agreement. These funds may be used for general corporate purposes. The unsecured revolving credit agreement contains certain financial and other covenants, customary representations, warranties, and events of default. As of June 29, 2008, we complied with all covenants pertaining to the credit agreement. There were no significant compensating balance agreements that legally restricted these funds. For more information, refer to the consolidated financial statements and notes included in our 2007 Annual Report on Form 10-K.

In August 2007, we entered into an unsecured revolving short-term credit agreement to borrow up to an additional $300 million because we believed at the time that seasonal working capital needs, share repurchases and other business activities would cause our borrowings to exceed the $1.1 billion borrowing limit available under our five-year credit agreement.  We used the funds borrowed under this new agreement for general corporate purposes, including commercial paper backstop.  Although the new agreement was scheduled to expire in August 2008, we elected to terminate it in June 2008 because we determined that we no longer needed the additional borrowing capacity provided by the agreement.

In May 2006, we filed a shelf registration statement on Form S-3 that registered an indeterminate amount of debt securities. This registration statement was effective immediately upon filing under Securities and Exchange Commission regulations governing “well-known seasoned issuers” (the “WKSI Registration Statement”). In March 2008, the Company issued $250 million of 5.0% Notes due April 1, 2013 under the WKSI Registration Statement. The net proceeds of this debt issuance were used to repay a portion of the Company’s outstanding indebtedness under its short-term commercial paper program.

The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximated fair value as of June 29, 2008 and December 31, 2007, because of the relatively short maturity of these instruments.

The carrying value of long-term debt, including the current portion, was $1,530.9 million as of June 29, 2008, compared with a fair value of $1,556.6 million, an increase of $25.7 million over the carrying value, based on quoted market prices for the same or similar debt issues.

The following table summarizes our foreign exchange activity:

Our foreign exchange forward contracts mature in 2008 and 2009.

We define the fair value of foreign exchange forward contracts as the amount of the difference between contracted and current market foreign currency exchange rates at the end of the period. On a quarterly basis, we estimate the fair value of foreign exchange forward contracts by obtaining market quotes for future contracts with similar terms, adjusted where necessary for maturity differences. We do not hold or issue financial instruments for trading purposes.

The total fair value of our foreign exchange forward contracts included in prepaid expenses and other current assets, accrued liabilities and non-current assets (liabilities), as appropriate, on the Consolidated Balance Sheets were as follows:

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 applies a consistent definition to fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements.

SFAS No. 157 establishes a fair value measurement hierarchy to price a particular asset or liability. The fair value of the asset or liability is determined based on inputs or assumptions that market participants would use in pricing the asset or liability. These assumptions consist of (1) observable inputs - market data obtained from independent sources, or (2) unobservable inputs - market data determined using the company’s own assumptions about valuation.

SFAS No. 157 establishes a fair value hierarchy to prioritize the inputs to valuation techniques, with the highest priority being given to Level 1 inputs and the lowest priority to Level 3 inputs, as defined below:

In addition, SFAS No. 157 requires disclosures about the use of fair value to measure assets and liabilities to enable the assessment of inputs used to develop fair value measures, and for unobservable inputs, to determine the effects of the measurements on earnings.

Effective January 1, 2008, we partially adopted SFAS No. 157 and have applied its provisions to financial assets and liabilities that are recognized or disclosed at fair value on a recurring basis (at least annually). We have not yet adopted SFAS No. 157 for nonfinancial assets and liabilities, in accordance with FASB Staff Position 157-2, Effective Date of FASB Statement No. 157 (“FSP 157-2”). FSP 157-2 defers the effective date of SFAS No. 157 to January 1, 2009, for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed on a recurring basis.

We use certain derivative instruments from time to time to manage interest rate, foreign currency exchange rate and commodity market price risk exposures, all of which are recorded at fair value based on quoted market prices or rates.

As of June 29, 2008, cash flow hedging derivative Level 1 assets were related to cash transfers receivable on commodities futures contracts reflecting the change in quoted market prices on the last trading day for the period. We account for commodities futures contracts in accordance with SFAS No. 133. We make or receive cash transfers to or from commodity futures brokers on a daily basis reflecting changes in the value of futures contracts on the IntercontinentalExchange or various other exchanges. These changes in value represent unrealized gains and losses.

As of June 29, 2008, cash flow hedging derivative Level 2 assets were principally related to the fair value of foreign exchange forward contracts. We define the fair value of foreign exchange forward contracts as the amount of the difference between the contracted and current market foreign currency exchange rates at the end of the period. We estimate the fair value of foreign exchange forward contracts on a quarterly basis by obtaining market quotes for future contracts with similar terms, adjusted where necessary for maturity differences.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and other items at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

As of January 1, 2008, we elected not to adopt the fair value option under SFAS No. 159 for any financial instruments or other items.

During the first quarter of 2008, the U.S. Internal Revenue Service commenced its audit of our U.S. income tax returns for 2005 and 2006. It is reasonably possible that this audit will be completed in 2009, but it is not possible at this time to estimate the resolution and any possible refunds or payments.

Components of net periodic benefits (income) cost consisted of the following:

We made contributions of $.5 million and $6.0 million to the pension plans and other benefits plans, respectively, during the second quarter of 2008.  In the second quarter of 2007, we made contributions of $2.7 million and $5.9 million to our pension and other benefits plans, respectively.  The contributions in 2008 and 2007 primarily reflected benefit payments from our non-qualified pension plans and post-retirement benefit plans.

In the second quarter of 2008, there was net periodic pension benefits income of $4.8 million, compared with net periodic benefits income of $2.2 million in the second quarter of 2007.  The higher net periodic pension benefits income primarily reflected the lower service cost resulting from a reduction in employment levels under the global supply chain transformation program.  The Special termination benefits, Settlement and Curtailment losses recorded in the second quarter of 2008 and 2007 primarily related to the 2007 business realignment initiatives.

We made contributions of $3.8 million and $11.9 million to the pension plans and other benefits plans, respectively, during the first six months of 2008.  In the first six months of 2007, we made contributions of $7.8 million and $10.4 million to our pension and other benefits plans, respectively.  The contributions in 2008 and 2007 primarily reflected benefit payments from our non-qualified pension plans and post-retirement benefit plans.

In the first six months of 2008, there was net periodic pension benefits income of $8.7 million, compared with net periodic benefits income of $3.6 million in the first six months of 2007.  The increased net periodic pension benefits

For 2008, there are no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans are not material.  During the remainder of 2008, we anticipate contributions to our pension plans of $25.0 million to $30.0 million which includes benefit payments from our non-qualified plans.

For more information, refer to the consolidated financial statements and notes included in our 2007 Annual Report on Form 10-K.

A summary of cumulative share repurchases and issuances is as follows:

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations (“SFAS No. 141R”), and Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS No. 160”). Both of these new standards are effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. These standards significantly change the accounting for and reporting of future business combinations and noncontrolling interests (minority interests) in consolidated financial statements. We are required to adopt these standards on January 1, 2009 and are currently evaluating their impact on our consolidated financial statements upon adoption.

SFAS No. 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired business. SFAS No. 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.

SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary and requires the noncontrolling interest to be reported as a component of equity. In addition, changes in a parent’s ownership interest while the parent retains its controlling interest will be accounted for as equity transactions, and any retained noncontrolling equity investment upon the deconsolidation of a subsidiary will be initially measured at fair value. Disclosures that clearly identify and distinguish between the interests of the parent and the interests of noncontrolling owners will be required.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133(“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities. Entities will be required to provide enhanced disclosures about how and why an entity uses derivative instruments, how these instruments are accounted for, and how they affect the entity’s financial position, financial performance and cash flows. This new standard is effective for

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”).  SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States.  We do not expect any significant changes to our financial accounting and reporting as a result of the issuance of SFAS No. 162.

In April 2007, we announced an increase of approximately four percent to five percent in the wholesale prices of our domestic confectionery line, effective immediately.  The price increase applied to our standard bar, king-size bar, 6-pack and vending lines. These products represent approximately one-third of our U.S. confectionery portfolio.

In January 2008, we announced another increase in the wholesale prices of our domestic confectionery line, effective immediately. This price increase also applied to our standard bar, king-size bar, 6-pack and vending lines and represented a weighted average increase of approximately thirteen percent on these items. These price changes approximated a three percent price increase over our entire domestic product line. We implemented both pricing actions to help partially offset increases in input costs, including raw materials, fuel, utilities and transportation.

Usually there is a time lag between the effective date of list price increases and the impact of the price increases on net sales.  The impact of price increases is often delayed because the Company honors previous commitments to planned consumer and customer promotions and merchandising events subsequent to the effective date of the price increases.  In addition, promotional allowances may be increased for certain products subsequent to the effective date, delaying or partially offsetting the impact of price increases on net sales.

Net sales for the second quarter of 2008 were higher than the comparable period of 2007 due to favorable price realization (as list price increases more than offset higher promotional allowances), incremental sales from the Godrej Hershey Ltd. acquisition, and a favorable foreign currency exchange rate.  These increases were slightly offset by sales volume decreases primarily in the United States reflecting lower seasonal sales and reduced sales of snack and refreshment products. The acquisition of the Godrej Hershey Ltd. business increased net sales by $17.0 million, or 1.6%.

Consumer takeaway decreased 11.5% during the second quarter of 2008 compared with the same period of 2007 as a result of an early Easter season which shifted sales into the first quarter of 2008.  Excluding seasonal sales, consumer takeaway increased 5.0%.  Consumer takeaway is provided for channels of distribution accounting for approximately 80% of our U.S. confectionery retail business. These channels of distribution include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores.

Market share in measured channels declined by 0.6 share points during the second quarter of 2008 also due to the earlier timing of the Easter season.  Excluding seasonal sales, market share in measured channels increased by 0.1 share points.  The change in market share is provided for measured channels which include sales in the food, drug, convenience store and mass merchandiser classes of trade, excluding sales of Wal-Mart Stores, Inc.

Cost of sales in the second quarter of 2008 was slightly higher than 2007.  The cost of sales increase was primarily associated with the Godrej Hershey Ltd. acquisition, higher costs associated with the introduction of new products and increased input costs. Input costs were only slightly higher in the second quarter of 2008 versus 2007, primarily reflecting lower costs for dairy products in 2008 compared with significantly higher costs in 2007 resulting from the recognition and timing of cost increases last year.  Reduced costs for product obsolescence and improved supply chain productivity also offset the cost of sales increase.  Business realignment charges of $15.0 million were included in cost of sales in the second quarter of 2008 compared with $41.3 million in the second quarter of 2007.

Approximately three-fourths of the gross margin increase was attributable to the impact of business realignment initiatives recorded in 2008 compared with 2007.  The rest of the increase resulted from favorable price realization, reduced product obsolescence costs and improved supply chain productivity. These increases were offset somewhat by the impact of the acquisition of the Godrej Hershey Ltd. business and increased input costs.

Higher selling, marketing and administrative costs were principally associated with employee-related expenses primarily reflecting increased levels of retail coverage in the United States, the expansion of our international businesses, including the acquisition of Godrej Hershey Ltd. and incentive compensation costs.  Incentive compensation costs increased in 2008 as compared to 2007 because of the impact of reduced performance expectations in the second quarter of 2007. Higher advertising and consumer promotion expenses related to the introduction of new products and increased core brand support also contributed to higher selling, marketing and administrative expenses. Expenses of $2.4 million related to our 2007 business realignment initiatives were included in selling, marketing and administrative expense for the second quarter of 2008 compared with $3.3 million recorded in the second quarter of 2007.

Business realignment charges of $21.8 million were recorded in the second quarter of 2008 associated with the 2007 business realignment initiatives.  The charges were primarily associated with employee separation and contract termination costs, fixed asset disposals and plant closure expenses.  Business realignment charges of $79.7 million were recorded in the second quarter of 2007 primarily associated with employee separation costs and losses on the sale of fixed assets, along with expenses for asset impairments, the closure of certain manufacturing facilities and the termination of certain contracts.

EBIT increased in the second quarter of 2008 compared with the second quarter of 2007 principally as a result of lower net business realignment charges.  Excluding the impact of business realignment charges, the increase in gross profit was more than offset by higher selling, marketing and administrative expenses.  Net pre-tax business realignment charges of $39.3 million were recorded in the second quarter of 2008 compared with $124.4 million recorded in the second quarter of 2007, a decrease of $85.1 million.

EBIT margin increased from 3.1% for the second quarter of 2007 to 8.5% for the second quarter of 2008. The impact of net business realignment charges in 2008 reduced EBIT margin by 3.6 percentage points and in the second quarter of 2007, reduced EBIT margin by 11.8 percentage points. The remainder of the decrease resulted from the higher selling, marketing and administrative expense as a percentage of sales.

Net interest expense was lower in the second quarter of 2008 than the comparable period of 2007 primarily reflecting lower average debt balances and lower interest rates in 2008 compared with 2007 in addition to an increase in capitalized interest.

Our effective income tax rate was 41.2% for the second quarter of 2008. The impact of tax rates associated with business realignment and impairment charges recorded during the quarter increased the effective income tax rate by 2.2 percentage points.

Net Income in the second quarter of 2008 was reduced by $25.5 million, or $0.11 per share-diluted, and was reduced by $78.1 million, or $0.34 per share-diluted, in the second quarter of 2007 as a result of net charges associated with our business realignment initiatives. After considering the impact of business realignment charges in each period, earnings per share-diluted in the second quarter of 2008 decreased $0.06 as compared with the second quarter of 2007.

The increase in net sales was attributable to favorable price realization from list price increases, substantially offset by sales volume decreases, primarily in the United States.  Incremental sales from our Godrej Hershey Ltd. acquisition and a favorable foreign currency exchange rate also contributed to the increase.  The acquisition of Godrej Hershey Ltd. increased net sales by $37.2 million, or 1.7%, in the first six months of 2008.

Consumer takeaway increased 1.6% during the first six months of 2008.  Consumer takeaway is provided for channels of distribution accounting for approximately 80% of our U.S. confectionery retail business.  These channels of distribution include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores.

Market Share in measured channels declined by 0.7 share points during the first six months of 2008.  The change in market share is provided for measured channels which include sales in the food, drug, convenience store and mass merchandiser classes of trade, excluding sales of Wal-Mart Stores, Inc.

The cost of sales increase in the first six months of 2008 compared with 2007 was primarily associated with the Godrej Hershey Ltd. acquisition and higher input costs, offset partially by favorable supply chain productivity and lower product obsolescence costs.  Lower business realignment charges included in cost of sales in 2008 compared with 2007 also partially offset the cost of sales increases.  Business realignment charges of $40.2 million were included in cost of sales in the first six months of 2008, compared with $51.2 million in the prior year.

The gross margin decline was related to higher input costs and our Godrej Hershey Ltd. acquisition, substantially offset by favorable price realization, lower obsolescence costs and improved supply chain productivity.  Approximately three-fourths of the gross margin decline was offset by lower business realignment charges recorded in 2008 compared with 2007.

Selling, marketing and administrative expenses increased primarily as a result of administrative and selling expenses and higher advertising and consumer promotion expenses.  Higher administrative and selling costs were principally associated with employee-related expenses from the expansion of our international businesses, including the acquisition of Godrej Hershey Ltd., investments to improve our selling capabilities and increased levels of retail coverage primarily in the United States, and higher incentive compensation expense.  Expenses of $3.9 million related to our 2007 business realignment initiatives were included in selling, marketing and administrative expenses in 2008 compared with $6.3 million in 2007.

Business realignment charges of $25.9 million were recorded in the first six months of 2008 compared with $107.3 million in the same period of 2007.  The charges in 2008 were primarily related to fixed asset impairments and plant closure expenses, in addition to employee separation costs, offset partially by gains on sales of fixed assets.  Business realignment charges recorded in 2007 primarily related to employee separation costs, fixed asset impairments and the closure of manufacturing facilities, along with the termination of certain contracts.

EBIT increased in the first six months of 2008 compared with the first six months of 2007 principally as a result of lower net business realignment charges associated with our business realignment initiatives.  Net pre-tax business realignment charges of $69.9 million were recorded in the first six months of 2008 compared with $164.8 million recorded in the first six months of 2007, a decrease of $94.9 million.  The increase in EBIT resulting from lower business realignment charges was substantially offset by higher selling, marketing and administrative expenses.

EBIT margin increased from 9.2% for the first six months of 2007 to 9.6% for the first six months of 2008. Lower net business realignment charges in 2008 improved EBIT margin by 4.5 percentage points. This impact was substantially offset by higher administrative expense and increased advertising and consumer promotion expenses as a percentage of sales, along with a lower gross margin.

Net interest expense was lower in the first six months of 2008 than the comparable period of 2007 primarily due to lower interest rates and an increase in capitalized interest in the first six months of 2008 as compared to the same period of 2007, along with a lower average debt balance in 2008.

Our effective income tax rate was 37.9% for the first six months of 2008 and was increased by 1.2 percentage points as a result of the effective tax rate associated with business realignment charges recorded during the first six months.  We expect our effective income tax rate for the full year 2008 to be 36.0%, excluding the impact of tax benefits associated with business realignment charges during the year.

Net Income in the first six months of 2008 was reduced by $46.2 million, or $0.20 per share-diluted, and was reduced by $103.4 million, or $0.44 per share-diluted, in the first six months of 2007 as a result of net charges associated with our business realignment initiatives.  After considering the impact of business realignment charges in each period, earnings per share-diluted in the first six months of 2008 decreased $0.20 as compared with the first six months of 2007.

Historically, our major source of financing has been cash generated from operations. Domestic seasonal working capital needs, which typically peak during the summer months, generally have been met by issuing commercial paper. Commercial paper may also be issued from time to time to finance ongoing business transactions such as the repayment of long-term debt, business acquisitions and for other general corporate purposes. During the first six months of 2008, cash and cash equivalents decreased by $83.8 million.

Cash provided from operations, long-term borrowings, cash on hand at the beginning of the period, and proceeds from the sale of property, plant and equipment was sufficient to fund the repayment of short-term debt of $430.9 million, dividend payments of $131.5 million, and capital additions and capitalized software expenditures of $146.5 million.

Cash used by inventories decreased from $166.6 million in 2007 to $95.6 million in 2008 primarily due to the impact of seasonal sales patterns and changes in inventory levels resulting from the global supply chain transformation program.

Cash used by changes in other assets and liabilities was $149.2 million for the first six months of 2008 compared with cash used of $153.8 million for the same period of 2007. Cash used by other assets and liabilities in 2007 and 2008 primarily reflected the impact of business realignment initiatives and the timing of payments for accrued liabilities associated with selling and marketing programs and incentive compensation.

During the first quarter of 2008, Hershey do Brasil entered into a cooperative agreement with Bauducco. We received cash of $2.0 million from Bauducco and recorded an intangible asset of $13.7 million related to the agreement. We will maintain a 51% controlling interest in Hershey do Brasil.

Proceeds from the sale of manufacturing and distribution facilities under the global supply chain transformation program were $76.9 million in the first six months of 2008.

A receivable of approximately $17.4 million was included in prepaid expenses and other current assets as of June 29, 2008 and $17.7 million as of December 31, 2007 related to the recovery of damages from a product recall and temporary plant closure in Canada.  The decrease primarily resulted from currency exchange rate fluctuations. The product recall during the fourth quarter of 2006 was caused by a contaminated ingredient purchased from an outside supplier with whom we have filed a claim for damages and are currently in litigation.

Interest paid was $47.3 million during the first six months of 2008 versus $62.5 million for the comparable period of 2007.  The decrease in interest paid resulted primarily from a bond maturity in the first quarter of 2007 and the lower interest rate environment.  Income taxes paid were $95.0 million during the first six months of 2008 versus $105.9 million for the comparable period of 2007.  The decrease in taxes paid in 2008 was primarily related to the impact of lower annualized taxable income in 2008.

The ratio of current assets to current liabilities increased to 1.1:1.0 as of June 29, 2008 from 0.9:1.0 as of December 31, 2007. The capitalization ratio (total short-term and long-term debt as a percent of stockholders’ equity, short-term and long-term debt) decreased to 76% as of June 29, 2008 from 78% as of December 31, 2007.

Generally, our short-term borrowings are in the form of commercial paper or bank loans with an original maturity of three months or less. In December 2006, we entered into a five-year credit agreement establishing an unsecured revolving credit facility to borrow up to $1.1 billion with the option to increase borrowings by an additional $400 million with the concurrence of the lenders. During the fourth quarter of 2007, the lenders approved a one-year extension to the term of this agreement in accordance with our option under the agreement. We may use these funds for general corporate purposes.

In August 2007, we entered into an unsecured revolving short-term credit agreement to borrow up to an additional $300 million because we believed at the time that seasonal working capital needs, share repurchases and other business activities would cause our borrowings to exceed the $1.1 billion borrowing limit available under our five-year credit agreement.  We used the funds borrowed under this new agreement for general corporate purposes, including commercial paper backstop.  Although the new agreement was scheduled to expire in August 2008, we elected to terminate it in June 2008 because we determined that we no longer needed the additional borrowing capacity provided by the agreement.

In March 2008, the Company issued $250 million of 5.0% Notes due April 1, 2013 under the WKSI Registration Statement. The net proceeds of this debt issuance were used to repay a portion of the Company’s outstanding indebtedness under its short-term commercial paper program.

The outlook section contains a number of forward-looking statements, all of which are based on current expectations.  Actual results may differ materially.  Refer to the Safe Harbor Statement below as well as Risk Factors and other information contained in our 2007 Annual Report on Form 10-K for information concerning the key risks to achieving future performance goals.

During the second quarter of 2008, we announced a new consumer-driven business model with a comprehensive approach to deliver sustainable growth over the coming years.  Our financial targets include long-term consolidated net sales growth targets in the three to five percent range and increases in earnings per share-diluted, excluding items affecting comparability, at an annual rate of six to eight percent.

Our net sales growth will primarily leverage our core portfolio of brands in the United States.  We expect to deliver focused, disciplined innovation by improving our price-value equation through package and product upgrades and merchandising improvements resulting in increased price realization.  We also expect growth from our international businesses primarily in faster-growing emerging markets.

Increases in earnings per share-diluted, excluding items affecting comparability, will be realized through aggressive productivity improvements and increased price realization, as we face continued commodity market volatility over the next several years.  We expect to continue our strong investment both in brand building and in emerging markets.

Our current business environment is characterized by significantly higher commodity costs and increased competitive activity. For the full year 2008, we expect increases in input costs versus 2007 of approximately $100 million, reducing gross margin by 200 basis points. We will also incur higher costs for increased investment in brand support and selling capabilities in the United States, while we are taking steps to enhance product innovation across our portfolio. We will also be continuing to invest in key international markets, particularly China and India.

To offset higher input costs, we have increased the wholesale prices of our domestic confectionery line and are implementing aggressive productivity and cost savings initiatives in addition to those already underway as part of our global supply chain transformation program. However, price increases and productivity improvements will only partly offset input cost increases and expenses associated with investment spending plans, resulting in lower EBIT and EPS, excluding items affecting comparability.

We expect consolidated net sales to grow 3% to 4% in 2008. We have introduced Hershey’s Bliss™ and Starbucks® branded chocolates and will introduce Reese’s Clusters packaged candy later this year to more fully participate in the rapidly growing premium and trade-up segments of the chocolate category in the United States. For the remainder of the Americas, we expect increases in net sales from our businesses in Canada, Mexico, and Brazil, along with incremental sales from the Godrej Hershey Ltd. acquisition.

For 2008, we expect total pre-tax business realignment and impairment charges for our global supply chain transformation program and restructuring our business in Brazil to be in the range of $135 to $145 million. We expect costs of approximately $85 million to be included in cost of sales, primarily for accelerated depreciation, and approximately $15 million to be included in selling, marketing and administrative expenses for project management and start-up costs. The remainder of these costs will be included in business realignment and impairment charges. Total charges associated with our business realignment initiatives in 2008 are expected to reduce earnings per share-diluted by $0.39 to $0.42.

As a result of higher input costs and increased investment in trade and consumer promotional programs and advertising, along with investment in our international businesses, we expect EBIT to decrease in 2008, excluding the impact of business realignment and impairment charges. We expect EBIT margin to decline due to investments in advertising, selling capabilities and building infrastructure for our international businesses.

Business realignment and impairment charges associated with our global supply chain transformation program and the restructuring of our business in Brazil will reduce net income and earnings per share-diluted in 2008. Excluding the impact of these business realignment initiatives, net income is expected to decline reflecting the increased investments in our businesses. As a result, earnings per share-diluted, excluding items affecting comparability, is expected to be within the $1.85 to $1.90 range for 2008.

A reconciliation of GAAP and non-GAAP items to the Company’s earnings per share-diluted outlook is as follows:

We believe that the disclosure of non-GAAP expected EPS-diluted excluding items affecting comparability provides investors with a better comparison of expected year-to-year operating results.  For more information on items affecting comparability refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2007 Annual Report on Form 10-K.

We now expect total pre-tax charges and non-recurring project implementation costs for the Global Supply Chain Transformation program of $550 million - $575 million.  Total estimated charges include project management and start-up costs of approximately $60 million.

We are subject to changing economic, competitive, regulatory and technological conditions, risks and uncertainties because of the nature of our operations. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we note the following factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions that we have discussed directly or implied in this report.  Many of the forward-looking statements contained in this report may be identified by the use of words such as “intend,” “believe,” “expect,” “anticipate,” “should,” “planned,” “projected,” “estimated,” and “potential,” among others.

Our results could differ materially because of the following factors, which include, but are not limited to:

The potential net loss in fair value of foreign exchange forward contracts of ten percent resulting from a hypothetical near-term adverse change in market rates was $.1 million as of June 29, 2008 and  $.2 million as of December 31, 2007.  The market risk resulting from a hypothetical adverse market price movement of ten percent associated with the estimated average fair value of net commodity positions increased from $31.7 million as of December 31, 2007, to $38.1 million as of June 29, 2008.  Market risk represents 10% of the estimated average fair value of net commodity positions at four dates prior to the end of each period.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of the end of the period covered by this quarterly report, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as required by Rule 13a-15 under the Exchange Act.  This evaluation was carried out under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer.  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.  There has been no change during the most recent fiscal quarter in our internal control over financial reporting identified in connection with the evaluation that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The Hershey Company’s Annual Meeting of Stockholders was held on April 22, 2008.  The following directors were elected by the holders of Common Stock and Class B Common Stock, voting together without regard to class:

The following directors were elected by the holders of the Common Stock voting as a class:

Holders of the Common Stock and Class B Common Stock, voting together, cast 693,416,793 votes against the proposal to establish a Board Committee on Human Rights, cast 5,407,355 votes in favor of the proposal and abstained from casting 18,209,503 votes on the proposal.

The following items are attached or incorporated herein by reference: